Capital Finance at the Local Level: Borrowing, Debt Management and Bankruptcy Provisions

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1 Capital Finance at the Local Level: Borrowing, Debt Management and Bankruptcy Provisions Ravikant Joshi Advisor CRISIL Infrastructure Advisory - Mumbai Chair Professor Urban Management St. Joseph s College of Business Administration - Bangalore

2 Capital Finance at Local Level Ways and Means Own Capital Resources revenue surplus + capital cost recovery + betterment charges + sale of assets Capital Grants Equity Debt (municipal bonds) Borrowings from DFIs (HUDCO, LIC), FIs, Commercial Banks, special intermediaries KUIDFC, MMRDA, TNUDF Project Financing Public Private Partnership

3 There exist some common views In Post Reforms Era - Economic and structural reforms have opened up plethora of capital financing options like - project financing, market borrowing (municipal bonds), PPP etc and now there are no supply side constraints Some ULBs/Utilities are successfully financing UI using these options and very soon others will adopt The problem is with ULBs/Utilities which lack financial health, credibility, bankable projects are responsible for non-development of urban infrastructure services There is a distinct credit averseness at local level Some are correct, some are incorrect

4 Capital Finance at Local Level in Pre-reform Era Capital rationing everything was part of plan alloc. Govt. Guaranteed bond qualifying for SLR. Loans from LIC, HUDCO on the basis of government guarantee Bank s term loan was the only source partially out of planning mechanism. But was not much of use to municipal bodies as it was characterised by High interest cost. Short to medium term. Excessive demand from each sector of economy as equity and debt market were not developed.

5 Capital Finance at Local Level in Pre-reform Era Was confined to Revenue surplus and own capital income of ULBs Paltry Capital grants from higher level government Borrowings administered through capital rationing mechanism, carrying administered negative (lower than market rate) interest rates supported by government guarantee

6 Capital Finance at Local Level Key Question Have Capital finance options really opened up in last decade? Are the issues on the supply or demand side? Are ULBs/Utilities resorting to capital finance? If so, is it mainly from financial intermediaries (DFIs)? Or from market (equity & bonds) or from banks Will supply side measures help weak ULBs?

7 Yes, ULBs/utilities are not resorting to capital finance No corporatisation of UIS, no equity raising A mere 16 bond issues by 13 agencies in 8 years and raised only Rs million including 2 pooled finance initiatives ULBs are borrowing on basis of balance sheet strength and not on strength of project As a result all bonds raised have been general obligation bonds and not revenue bonds. Also the bonds were SO Tax Free Status has not motivated them to issue bonds and now in 2006 budget tax free status has been withdrawn Capital Financing - Not Explored, Not Preferred, Not Adopted.

8 Capital Financing - Not Explored, Not Preferred, Not Adopted. Demand for DFI lending is low: Only 33 loan proposals from 28 agencies to HUDCO in past three years: urban sector lending amounted 8% of HUDCO s lending No borrowing from LIC in last five years as LIC has stopped lending to ULBs/Utilities No project finance via IDFC, IL&FS Except one or two no Real PPP initiatives Even investment grade capacity has not necessarily increased the appetite for capital financing (borrowings) May be preferred in future because of JNNURM.

9 Seems Less likely. Against the total CAPEX of Rs crores proposed by 24 cities under JNNURM only Rs crore borrowing is envisaged (7.44%) Envisaged borrowing is not examined from capacity to borrow and service debt aspect Only 9 out of total 79 sanctioned DPRs indicates plan and probability of borrowing Only 3 out of 79 sanctioned DPRs show probability of PPP In sum it means.

10 Capital Finance at Local Level in post-reform Era is confined to Revenue surplus and own capital income of ULBs Borrowing from Banks and calibrating their borrowing (short term) to what banks can provide Forced top down lending to local bodies by state government though LBs are non-investment grade Paltry Capital grants from higher level government till today, In future, to sizeable JNNURM Grant But not to Equity or debt financing Borrowings from DFIs HUDCO, LIC Borrowings from SFIs Project financing or PPP Why.

11 Obvious cause.. lack of financial health NIPFP study for 12 th CFC and 12 CFC: Per capita total revenue of ULBs was Rs. 706 in , less than Rs. 2 per day Average per capita expenditure ranges from Rs to Rs Poor credit ratings No AAA rated ULB/Parastatal till date Highest rating by any ULB or Utility so far AA+(SO) Except HMWSSB & NMC who got A rating all live ratings are SO Not more than 40 ULBs have investment grade But issues go deeper.

12 And are complex too. Even investment grade capacity has not necessarily increased the appetite for capital financing (borrowing) High credit averseness among most ULBs Local bodies adopt incremental approach towards capital investment due absence of long tenure loan products. No compulsion to give first try to other options of capital finance High cost loans make borrowing unviable for weal ULBs Lack of debt management capabilities No debt limitation & bankruptcy Provisions in law Contrary to belief exist on supply side too.

13 And are really overarching Market players are unable to offer/to provide A cost competitive long tenure loan product because of Asset-liability mismatch (in case of banks), Government regulations (insurance funds and pension funds), Business focus (IDFC, IL&FS) Cost of funds (HUDCO) A competitive product for low investment grade ULBs Funds to speculative grade ULBs due to lack of risk appetite Absence of Credit enhancement mechanism Inadequate legal framework for risk mitigation

14 Flow of funds provide skewed incentives Mode of Savings Pattern of investments 100% Pension Funds 90% 80% 70% 60% 50% 40% 30% Household savings Insurance funds Government bonds and saving schemes Shares and debentures Deposits Invested in 20% 10% 0% Cash 10 Government PSEs Guaranteed AAA, AA A, BBB Non investment Investment grade CRISIL Infac Research RBI Data

15 Tenure in Years Gaps in UI & UWSS Sector Financing System Bond Markets, HUDCO Credit enhancement Competitive bank loans High cost loans from LIC, HUDCO with guaranteed by State Governments High cost bank loans Possible State level pool product IIFC? Bond Markets, IDFC High Investment grade Risk Low Investment grade Speculative grade Urban Local Bodies Project Vehicles

16 The deepest root causes are outside the capital finance system Lack of fiscal responsibility and budgetary norms for ULBs/Utilities inadequate but free/easy funds are made available to ULBs/Utilities Lack of development or performance accountability to people even ULBs with resources sit on funds rather than carrying development People fail to convert their needs in to real demands, fail to pressurise ULBs/utilities to perform or to deliver People fail to own responsibility of paying right price and demanding right service

17 Capital Finance at Local Level In sum Contrary to general belief supply side (availability) of capital finance has not increased or opened up in post reform era Short term cost effective funds are available to investment grade ULBs which are less than 50 in numbers in the country Long term cost competitive funds are not available even for financially healthy ULBs Market players are ready to lend to investment grade ULBs but they are not ready to borrow credit averseness Market players lack risk appetite to lend to low or no investment grade ULBs Most of the ULBs lack financial capacity no capital financing through own sources or other sources only through capital grants and through the loans thrust by state governments

18 Capital Finance at Local Level In sum ULBs having investment grade find most of the market players and their products non-cost competitive No efforts by ULBs to improve their financial health Local bodies adopt short term and incremental approach towards capital investment High averseness for alternative sources among most ULBs as they involve decision making Lack of capacity, lack of knowledge ULBs/Utilities are not under pressure to improve, there is lack of performance and development accountability

19 Capital Finance at the Local Level: Borrowing, Debt Management and Bankruptcy Provisions Thank You